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# Assessment Task – Tutorial Questions Assignment Unit Code: HC2091

Assignment: Tutorial Questions Assignment (Individual)

Weighting: 50% Purpose:

This assignment is designed to assess your level of knowledge of the key topics covered in this unit

Description:

Each week students were provided with three tutorial questions of varying degrees of difficulty. The tutorial questions are available in the Black Board/ Tutorial Materials/ Tutorial Questions for Final Assessment for each week. The Interactive Tutorials are designed to assist students with the process, skills and knowledge to answer the provided tutorial questions. Your task is to answer a selection of tutorial questions from week 3 to week 11 inclusive and submit these answers in a single document.

The questions to be answered are:

Question 1(11 marks)

(This question is from the Week 4 Tutorial)

1. Your manager asked you to evaluate an investment opportunity. Select and explain two (2) investment criteria you will use to make a decision as to whether to accept or reject the opportunity. (2.5 x 2 = 5 marks)
2. You are the CFO of Midas Mining Ltd and the company is looking to expand its mining operations. Your staff have narrowed it down to two (2) projects, with the cash flows presented in the table below. However, given the substantial cash outlay, your company can only choose one of the projects (A or B).
 Information Project A Project B Cost \$5 550 000 \$6 640 000 Future Cash Flows Year 1Year 2Year 3Year 4Year 5 1 230 0002 210 0001 200 6001 150 0001 120 000 2 830 0001 300 0001 750 0001 180 0001 150 000

## Required:

1. Perform a project evaluation, using the Net Present Value (NPV) method. The prevailing discount rate is 12%. (2.5 x 2 = 5 marks)
2. Identify which project (if any) should be accepted by Midas Mining Ltd. (1 mark)

Question 2(11 marks)

(This question is from the Week and Week 4 Tutorials)

Alice has \$5 000 now. She wants to save \$25 000 to buy her first car. She decides to put that \$5 000 in an investment fund that pays an interest rate of 10% per annum (per year), compounding annually.

Required:

1. How long does Alice need to wait until she has saved \$25 000? (2 marks)
2. If Alice wishes to have that \$25 000 in five (5) years, how much does she need to put into the investment now with the same interest rate of 10%? (2 marks)
3. Assume that Alice was offered an alternative investment, which requires an initial investment of \$6 000 for seven (7) years. Calculate the amount of money that Alice would accumulate after seven (7) years, if the rate of return is 12%, compounding quarterly.(2 marks)
4. Assume that Alice was offered two (2) other alternative investments in the securities market:
1. Option A pays an interest rate of 10% p.a. (per year), compounding semi- annually.
2. Option B pays an interest rate of 9.87%, compounding monthly. Which option (A or B) should Alice choose? (2 marks)
5. Assume that Alice has achieved her goal of \$25 000 as a deposit and now she wants to purchase a car which costs \$45 000. Her plan is to pay \$25 000 in cash and finance the balance over three (3) years at an interest rate of 3.5%. What will be her monthly payment? (2 marks)
6. At the end of this year, Alice will receive a fixed income of \$10,000 each year forever. If the required rate of return is 14%, what is the present value of this income flow?

(1 mark)

Question 3(7 marks)

(This question is from the Week and Week 8 Tutorials)

MLC Fund Management is considering the following three (3) options for their new investment portfolio:

Option 1 - A non-callable corporate bond that pays a coupon rate of 8% annually. The bond will mature in 30 years. The yield-to-maturity (YTM) of the bond is 7.5% and the face value of the bond is \$1 000.

Option 2 - An ordinary share which just paid a dividend of \$6.00 with a constant dividend growth rate of 5% each year. The current market price of this share is \$85.

Option 3 - A \$100 par value preference-share which pays a fixed dividend of 6%. The required rate of return for the preference shares with the same risk is 8%.

Required:

1. How much should MLC pay for the corporate bond that pays the coupon annually? (1 mark) If the coupon is paid quarterly, what is the new bond value? (1 mark)
2. Calculate the market required rate of return for the ordinary share. (1 marks)
3. Compute the value of the preference share. (1 mark)
• Explain why a preference share is considered a hybrid between an equity and a debt instrument. (3 marks)

Question 4(7 marks)

(This question is from the Week 9 Tutorial)

Marcus has an investment portfolio that paid the rate of return of 24.75%, -11%, - 30%, 19%, 15.5%, 12% and 20% over the last seven (7) years.

Required:

1. Calculate the arithmetic average return and the geometric average return of this portfolio. (2 marks)
2. Discuss the difference between arithmetic average return and the geometric average return. When should Marcus use a specific average return? (2 marks)
3. If the following information is available for Marcus’s portfolio in the forecast for next year, calculate the expected return and identify the risk of return by computing the variance and the standard deviation. (3 marks)
 State of economy Probability of the economic state Rate of Return Boom 0.55 25% Normal 0.30 17% Recession 0.15 -8%

# Question 5(7 marks)

(This question is from the Week 10 Tutorial)

Osborne Construction currently has the following capital structure:

Debt: \$20,500,000 paying 9.5% coupon bonds outstanding with 15 years to maturity, an annual before-tax yield to maturity of 8% on a new issue. The bonds currently sell for

\$1,125 per \$1,000 face value.

Ordinary Shares: 100,000 shares outstanding currently selling for \$45 per share. The company just paid a \$3.50 dividend per share and is experiencing a 5% growth rate in dividends, which it expects to continue indefinitely.

(Note: The firm's marginal tax rate is 30%.)

Required:

1. Calculate the current total market value of the company. (1.5 marks)
2. Calculate the capital structure of the company. (1 marks)
3. Calculate the weighted average cost of capital (WACC) for the firm. (1.5 marks)
4. Discuss the significance of calculating WACC for this company. (3 marks)

Question 6(7 marks)

(This question is from the Week 11 Tutorial)

The following data is available for Quick Serve Trading Ltd.

 Account Beginningbalance Ending Balance Accounts payable 120,300 124,400 Inventory 160,600 167,200 Long term debts 327,500 325,800 Common stock 400,400 415,900 Accounts receivable 123,400 122,300 Total revenue 737,000 Total cost of sales 265,000

(Note - Assume that all sales are on credit)

Required:

1. Calculate the operating cycle (2.5 marks) and the cash cycle (2.5 marks)
2. Interpret and explain the outcomes (2 marks)

# a) Investment appraisal criteria –

• Net present value – Net present value is the difference between the present value of cash inflow to present value of cash outflow. The positive NPV represents that the project is profitable and the negative NPV represents the loss in the project. therefore, the project with a positive NPV should be acceptable.
• Payback period – payback period means how much time the initial investment will get back to the organization. It indicates the liquidity in the project. if the payback period is within the permissible limit then the project will be acceptable otherwise the project will not be admissible by the organization.

b) Net present value:

 Years Project A Project B Cash flows PVF PV Cash flows PVF PV 0 -5550000 1 -5550000 -6640000 1 -6640000 1 1230000 0.893 1098214 2830000 0.893 2526786 2 2210000 0.797 1761798 1300000 0.797 1036352 3 1200600 0.712 854563 1750000 0.712 1245615 4 1150000 0.636 730846 1180000 0.636 749911 5 1120000 0.567 635518 1150000 0.567 652541 NPV -469060 -428795

(ii) Both the projects of the company have a negative net present value therefore both the projects should not be acceptable by the company.

Question 2:

a) Time for saving \$ 25000:

Principal = 5000, Amount = 25000, Interest = 10 %, time =?

Amount = Principal (1+rate) ^t

25000 = 5000 (1+10%) ^t

T = 17 Years (Approx.)

b) Calculation of investment amount:

Principal =? Amount = 25000, Interest = 10 %, time =5 years

25000 = Principal (1.1) ^5

c) Return on investment:

Principal = 6000, Rate = 12/4 = 3 %, time = 7*4 = 25 quarter, amount = ?

Amount = 6000 * (1.03) ^28

d) Effective annual interest

Option A = 10.25 %

Option B = 10.33 %

Therefore, option B is better than option A and the amount is invested in option B.

e) Amount of monthly payment:

Amount of loan = \$ 45000 - \$ 25000 = \$ 20000

Time = 3 years

Interest rate = 3.5 %

Monthly payment = \$ 586

f) PV of income flow:

Fixed income received each year=\$ 10000

Required rate of return=14 %

PV of income=\$ 10000 / 14%= \$ 71429

Question 3:

a) Value of bond:

Value of bond =PV value of face value + PV of interest received

When coupon rate is paid annually:

1000 * 0.114 + 80 * 11.81=\$ 1058.80

When coupon rate is paid quarterly:

1000 * 0.114 + 20 * 47.59=\$ 1065.80

b) Required rate of return:

Current market price= Dividend * (1 + growth rate) / Ke – Growth rate

\$ 85=6 * (1 + 0.05) / Ke – 0.05

Ke=12.41 %

c) Value of Preference share:

Value of preference share=Dividend / required rate of return

=\$ 6 / 8 %=\$ 75

d) Hybrid of preference share:

The preference share has the characteristics of both equity shares and bonds. As there are fixed returns on preference share as the rate of dividend is predetermined and the payment is considered as a dividend. The risk is low as compared to equity shares and returns are high as compared to equity shares also the risk is high as compared to bonds and returns are low as compared to bonds. Therefore the preference shares are considered as a hybrid between equity and debt instrument.

Question 4:

a) Valuation of AAR and GAR

 Years Return 1 24.75% 1.2475 2 -11% 0.89 3 -30% 0.7 4 19% 1.19 5 15.50% 1.155 6 12% 1.12 7 20% 1.2 Arithmetic average 7.18% Geometric average 5.30%

## b) Arithmetic mean v/s geometric mean:

The arithmetic mean is the average of the data set in the arithmetic mean the sum of the data set is divided by the numbers in the data set to get the arithmetic mean, whereas in the geometric mean the product of the numbers are calculated and then these products are rising to the length of its series. The geometric mean considers the compounding effect from period to period whereas the average return or arithmetic return does not incorporate the compounding return in it. Therefore when the investors analyze any portfolio they take the geometric mean over the arithmetic mean.

c) Calculation of expected return, variance, and standard deviation:

 State of economy Probability Rate of return p*X = Mean (X-Mean) (X-Mean)^2 Boom 0.55 25.00 13.75 11.25 126.5625 Normal 0.3 17.00 5.1 11.90 141.61 Recession 0.15 -8.00 -1.2 -6.80 46.24 17.65 314.4125

Expected return = 17.65 %

Variance = 314.4125

Standard deviation = (314.4125) ^1/2 = 17.73

Question 5:

a) Total market value of the company

 Script Calculation Market Value Debt 20500000/1000*1125 23062500 Equity 100000*45 4500000 The total Market value of the firm 27562500

## b) Capital structure of the company:

 Script Calculation Market Value Capital structure Debt 20500000/1000*1125 23062500 0.84 Equity 100000*45 4500000 0.16 The capital structure of the company 27562500 1.00

## c) Weighted average cost of capital:

Cost of equity –

D1 = 3.5 * 1.05 = 3.675

P = 45

G = 5%

Ke =?

45 = 3.675 / (Ke-.05)

Ke = 13.17 %

Cost of debt = 8 * (1 -.3) = 5.6 %

 Script Calculation Market Value Capital structure Cost WACC Debt 20500000/1000*1125 23062500 0.84 5.60% 5% Equity 100000*45 4500000 0.16 13.17% 2% The capital structure of the company 27562500 1.00 7%

## d) Importance of weighted average cost of capital –

The weighted average cost of capital is the cost of the funding of the company, any project that is accepted by the company must be earning more than the WACC. In the company the capital structure outrightly debt intensive the company has an 84 % debt in the total capital structure of the company and a weighted average cost of capital is 7 %. The cost of debt post-tax is 5.6 % and the cost of equity is 13.17 %.

Question 6:

a) Calculation of the operating cycles and cash conversion cycle

Operating cycles = days of sales outstanding + days of inventory outstanding

Days of sales outstanding = [(Opening debtors + Closing debtors)/2] / (Revenue/365)

Days of sales outstanding = (123400+122300)/2] / (737000/365)

DSO = 61 Days

Days of inventory outstanding = [(Opening Inventory + Closing Inventory)/2] / (COGS/365)

Days of inventory outstanding = [(160600 + 167200)/2] / (265000/365)

= 226 days

Operating cycle = 61 +226 = 287 days

Cash conversion cycle = operating cycle – days of suppliers outstanding

Days of supplier outstanding = [(Opening payables + Closing payables)/2] / (COGS/365)

= 169 days

Cash conversion cycle = 287 -169 = 118 days

b) Explanation of outcomes:

As the operating cycle is 287 days which shows there is a lack of liquidity from debtors and inventories. The company has a lack of efficiency in recovering the cash and liquid from the sales of inventories. The operations of the business is depending on the liquidity of the company and the high operating cycle may cause the problem of liquidation in case of emergency and instant need of cash funds. The high operating cycle denotes the blockage of the fund in inventories and debtors.

The cash conversion cycle is 118 days which shows the company has a net cash conversion period after payment of creditors. The high cash conversion cycle is not good for the company as the company has a block of funds in inventories and debtors and liable to pay dues to suppliers and creditors. The company has a liquidation problem in this case as the net cash conversion may take approx 3 months and a decrease in days of supplier outstanding may impact the financial feasibility of the company.

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